IN a swift operation earlier this month, the Reserve Bank of India (RBI), the country’s central bank, dealt a severe blow to the buoyant bitcoin segment that was fast taking root in the country.

Similar to many countries around the globe, India, too, is worried that unregulated virtual currencies could help operators indulge in illegal activities including money laundering, tax evasion and fraud.

While Finance Minister Arun Jaitley had earlier declared bitcoin and other virtual currencies as illegal — even comparing them to Ponzi schemes — the central bank had not indicated any rush to ban them.

But at its first bi-monthly monetary policy committee meeting for the current fiscal, the RBI declared that regulated entities providing services to individuals or businesses dealing in digital currencies have been given three months to exit the relationship.

B.P. Kanungo, deputy governor RBI, says that the central bank had on at least three occasions cautioned the public and users of virtual currency about the risks they were exposing themselves to through cryptocurrencies.

“We have now decided to fence RBI-regulated entities from the risk of dealing with entities associated with virtual currencies,” he said. “They are required to stop having a business relationship with entities dealing with virtual currencies forthwith, and unwind the existing relationship within three months.”

RBI declared that regulated entities providing services to individuals or businesses dealing in digital currencies have been given three months to exit the relationship as reports of fraud worth around Rs 194m surfaced

According to him, if cryptocurrencies grow beyond a critical size they can endanger financial stability in the country.

There have also been fears of cryptocurrencies funding illegal activities including fraudulent investment operations that could result in thousands of investors being defrauded of millions of rupees.

Companies that were enjoying vibrant operations complain that the central bank did not consult many outsiders or seek public opinion, nor were conducted opinion polls. Worse, the findings of a committee to look into the matter were also not published.

But the RBI itself has decided to promote the use of blockchain, a public ledger that has been the backbone of bitcoin, to ensure transparency and improve inclusion.

The RBI plans to introduce a flat digital currency, as central banks elsewhere in other parts of the world have done. “These are issued by the central bank and are considered its liability,” says Kanungo. “They will be in circulation in addition to the paper currency that we have. It also holds the promise of reducing the cost of printing notes.”

An inter-departmental committee has been set up by the central bank to submit a feasibility report on a flat digital currency by the end of June.

Bitcoins were trading in India at about Rs480,000 ($7,360) immediately after the RBI directions, much below the international market price. However, by last week they had recovered and were quoting at around Rs520,000, whereas internationally it was around $8,105 (Rs532,000).

While the sudden RBI decision shook up the bitcoin market in India, many players have come up with alternative plans. It is argued that the cryptocurrency business itself has not been declared illegal by the government, and only banks have been prevented from dealing with them.

Some of the players have decided to challenge the RBI move in the Supreme Court. Cryptocurrency startup Kali Digital Ecosystems has already filed a writ petition in the Delhi high court challenging the ban on crypto dealings. The firm was planning to start Coin Recoil, a cryptocurrency exchange, in August, but its plans were shattered by the RBI.

In its plea, the company claims that it will not be able to avail banking services for the cryptocurrency exchange and will not be able to conduct its proposed business. It described the RBI policy of prohibiting banks from dealing with cryptocurrency firms as unconstitutional.

Besides the RBI, it has also dragged in the ministry of finance and the Goods and Service Tax Council for their failure to introduce laws to treat cryptocurrencies.

MANY countries around the world, including Japan, China, South Korea and Vietnam have also cracked down on cryptocurrencies. China, once a hub for cryptocurrency trading, has made them illegal, while Japan and South Korea have also set up new regulations.

There are fears in India that many of the operators would shift operations to cryptocurrency-friendly countries including Switzerland, Estonia, Malta, Cayman Islands, Dubai and Singapore.

But it is only the large cryptocurrency firms who will opt for this move; the smaller ones — who do not have the means to relocate to another country — would just have to shut down.

Some in the cryptocurrency business feel that there is also the peer-to-peer transaction, in which only the buyer and the seller of cryptocurrencies are involved. But it would involve a lot of cash transactions, which are not quite popular in India now.

There is also the fear that disputes can arise between two players, which would be difficult to resolve in the absence of official payments. India’s cryptocurrency market was growing rapidly, with nearly 5m investors and investments touching the $2 billion mark.

But of late there have also been cases of fraud and cheating that have surfaced. Coinsecure, a leading cryptocurrency exchange, said nearly $3m were stolen from its bitcoin wallet, allegedly by one of the senior partners.

Just a week after the RBI banned banks from dealing in crypto-currencies, the chief strategy officer of a leading exchange siphoned off bitcoins worth Rs190m.

Access to the bitcoin wallet was restricted to the CEO and another senior officer, Amitabh Saxena, who allegedly cooked up a false story and stole the funds. The company has filed a complaint with the Delhi police and has asked the government to seize Saxena’s passport to prevent him from leaving India.

Published in Dawn, The Business and Finance Weekly, April 23rd, 2018